January 08, 2020
Trust & Estates Alert
Trust & Estates Alert
Author(s): Sarah M. Richards
The SECURE Act imposes tightened distribution requirements on many of the beneficiaries of inherited retirement plans which may have a negative impact on the plan owner’s and beneficiary’s estate and income tax planning.
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. The Act makes significant tweaks to retirement plans to give Americans more and easier access to setting aside their own funds for retirement, but also imposes significant new timing restrictions on distributions for certain beneficiaries of these plans. The Act became effective January 1, 2020.
The Act has substantial effects on the estates of people who will leave significant sums in their IRAs and 401(k)s and on the beneficiaries of those plans. For plan owners, retirement assets may be a significant component in their estate planning. The beneficiaries who inherit those assets at the owner’s death have to plan for the income tax consequences of receiving distributions and may need to re-think their estate own plans.
The SECURE Act imposes tightened distribution requirements on many of the beneficiaries of inherited retirement plans. Those requirements may have a negative impact on estate and financial planning.
Before the SECURE Act, certain beneficiaries of IRAs had the ability to stretch out the minimum required distributions (“MRDs”) over their own life expectancies — the so-called “Stretch IRA.” Since most IRAs accumulate tax-free and are subject to income tax only upon distribution to the plan holder or beneficiaries, this stretched-out timeframe allowed disciplined beneficiaries to continue to grow their IRAs and spread the income tax hit over (potentially) many years.
Estate planning for retirement assets often involved naming a client’s trust as the designated beneficiary of his/her IRA, thus braiding the Stretch IRA into the trust. The stretched-out IRA distributions would merge into the decedent’s trust over time. Proper estate and income tax planning required either that the trust include provisions requiring the IRA payments to be distributed to the trust’s beneficiaries on a current basis, or carry out a complex analysis of highly technical rules permitting accumulation of retirement plan benefits in a trust. This type of careful planning minimized the income tax consequences inherent to traditional IRAs and 401(k)s, and allowed the IRA distributions to benefit the decedent’s spouse and children/grandchildren over as long a period as possible.
The SECURE Act eliminates the stretch for most beneficiaries designated by the plan owner. For IRAs of people who die after December 31, 2019, the IRA must be paid to the designated beneficiary over 10 years unless the beneficiary falls into one of five exceptions:
With the elimination of the Stretch IRA, trusts may become problematic beneficiaries of retirement plan assets. The forced compression of inherited IRA payments will not necessarily work well in a trust framework. The SECURE Act’s mandatory distribution rules may conflict with the trust settlor’s goals of providing for all family members over as long a period as possible.
Furthermore, because most retirement plan distributions are subject to income tax, this collapsed payout forces the income tax due on the distributions to be accelerated. The accelerated payment schedule means that the inherited IRA assets will not enjoy long-term tax-sheltered growth and that the distributions may push the beneficiaries’ income into a higher tax bracket.
The impact of the elimination of the Stretch IRA and the imposition of a 10-year distribution period can be measured by the government’s assessment of the income tax that will be collected as a result of the change. The Congressional Research Office reported that an additional $15.7 billion in revenue would be raised as a result of the shortened distribution period.
The SECURE Act, among many other provisions, also:
People with significant retirement plan assets should speak with their estate planning counsel to understand how the SECURE Act affects their planning and to adjust their estate plans and beneficiary designations accordingly.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.
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